The lowest-rated junk bonds plunged 16 percent in the second half of 2015, losing an estimated $27.9 billion of market value. While values have recovered a bit, these notes still have an average yield of 18.9 percent, well above the decadelong average of 13.4 percent. New high-yield bond sales have shriveled up this year, especially for the most-leveraged companies. Investors are demanding enhanced premiums and companies are being forced to comply because they have no other choice.

Bigger Expense

The riskiest companies are paying a bigger premium to borrow relative to safer ones

Source: Bank of America Merrill Lynch index data

This isn't a terribly complacent bubble, if it is one. And it may be the best telegraphed one -- analysts, policy makers and investors have been warning about stretched valuations in high-yield corporate debt for years. While UBS is right to worry about accelerating bankruptcies, meager recoveries and historic losses on this debt, such an outcome can't possibly be entirely unexpected at this point.

The bigger risk of a systemwide shock probably lies with companies still perceived as creditworthy. Big established corporations and nations around the world are still enjoying incredibly cheap borrowing costs at a time of growing economic angst. After a slow start to the year, U.S. investment-grade bond issuance has since soared to a record pace. Investors are demanding just 1.7 percentage points of additional yield over benchmarks to own this debt, below the decadelong average of 1.9 percentage points. All-in yields are close to record lows.

Shrinking Cushions

Yields on U.S. investment-grade bonds have fallen back to near-record lows

Source: Bank of America Merrill Lynch index data

This debt is still thought of as completely safe, a proxy for government debt to buy if investors want to earn a wee bit more income. And yet these bonds are as vulnerable to hiccups as ever, in large part because their protective cushion of yield has shrunk substantially.

What happens if benchmark rates rise suddenly? While this hasn't happened for a while, both the Federal Reserve and some big bankers are worried that a surge in 10-year U.S. yields could significantly disrupt world markets. Yields on the debt have fallen, even as inflation shows signs of picking up. It would be harder for investment-grade bond investors to absorb the resulting losses from rising rates given their diminished relative yields.

Or let's say that a company that's perceived as safe suddenly undergoes a rapid loss of confidence, either because of accounting fraud or significantly lower earnings.

Indeed, earnings at the largest U.S. companies are declining, with analysts predicting that net income just plunged 10 percent in the worst performance since the aftermath of the financial crisis in 2009. If profits continue to dwindle, it will become more difficult for these companies to repay the trillions of dollars they've borrowed. Potential downgrades of top-rated companies may prompt many holders to have to sell the debt, leading to a rapid deterioration in prices on billions of dollars of bonds.

That's not to say the lowest-rated debt isn't risky. More pain is on the way there. UBS analysts predict $1 trillion of debt will end up distressed as the credit cycle turns. A recession would certainly add stress to the financial system on many levels, especially because of the degree of corporate leverage spurred by years of unconventional monetary policies.

But even then, the bigger risk could be lurking in debt that’s perceived as safe. This debt acts as a hideout. It's where investors are comfortable, and that's where they're more likely to get a rude awakening.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.